National Pension System may undergo major overhaul

New Delhi: The National Pension System (NPS) could be in for a major overhaul.

A committee set up to review investment guidelines for the NPS has recommended not only a shift in the investment strategy from passive to active fund management, but also proposed relaxing investment norms for pension funds and giving investors the freedom to decide the assets they want to put their money in and how much they want to invest.

The committee under G.N. Bajpai, former chairman of Life Insurance Corporation of India and the Securities and Exchange Board of India (Sebi), was set up by the Pension Fund Regulatory and Development Authority (PFRDA), the sector regulator, in September 2014. It submitted its report on 7 April.

NPS currently follows a “quantitative portfolio regulation” approach toward investments of pension assets. This approach prescribes the limits for investment in certain assets that are perceived by the regulator to be risky. This leads to a system of directed investments in which the regulator prescribes the assets as well as the caps on investment in these assets.

For instance, NPS rules for the private sector allow a maximum exposure to equity of 50% and only through index funds that replicate either the BSE’s Sensex or the National Stock Exchange’s Nifty 50 index. Index funds mimic movements in the index to which they are linked. This form of investment is called passive investment. For government sector employees, equity exposure is limited to 15%.

The report of the Bajpai committee recommends moving from this directed investment regime to one that leaves the choice of investment of pension assets to the subscriber.

“Based on her perception of risk and financial situation in life, the subscriber is expected to exercise the choice, as a prudent investor would,” the report said. In others words, an investor will not only be able to decide the exposure to an asset class but will be given a wider choice.

“The movement from the directed investment regime to the prudent investor regime shall entail not only easing of the ceilings for each asset class, but also allowing wider choice of instruments under each asset class across the board,” said the report.

Allowing a wider choice would lend itself to a system of active management.

“This could mean expanding the universe of instruments under equity from merely mirroring any index to investing in securities with derivatives on the stock exchange and expanding into other capital market instruments (primary and secondary) even further as the market matures, with suitable caveats and ceilings,” the report said.

But keeping costs low under active management of funds can pose a challenge, experts said.

“This is digressing from the original thought process. Active management and low costs don’t go hand-in-hand. Therefore, in order to keep costs low and manage public money, passive fund management is the best option,” said Manoj Nagpal, chief executive officer, Outlook Asia Capital, a wealth management firm.

The committee has also recommended harmonizing investment guidelines for the NPS across the government and the private sector so that both follow the same pattern of investments—a proposal that has been welcomed as positive. This will allow the government NPS scheme a higher exposure to equity of up to 50%.

The report also proposes allowing private fund managers to manage the government’s money pension funds. Currently only public sector pension fund managers are allowed to manage the government NPS funds. Because the private sector NPS is still struggling to gain traction, this restriction makes it difficult for private pension fund managers to sustain fund management at low costs.

“The merger is a very good step as that’s the only way to achieve economies of scale,” said Nagpal. As of 30 April 2015, the total assets under management of NPS stood at Rs.83,917 crore. Of this, only aboutRs.6,448 crore is from the private sector.

Currently the government sector is managed by three fund managers—SBIPension Funds Pvt. Ltd, UTI Retirement Solutions Ltd and LIC Pension Fund Ltd. Contributions are allocated to these three managers in a predefined proportion and they invest the funds in pre-determined proportion: Up to 55% in government securities, up to 40% in debt securities, up to 15% in equity and up to 5% in money market instruments.

In the case of the private sector NPS, there are currently seven public and private fund managers—HDFC Pension Management Co. Ltd, ICICIPrudential Pension Fund Management Co. Ltd, Kotak Mahindra Pension Fund Ltd, LIC Pension Fund, Reliance Capital Pension Fund Ltd, SBI Pension Funds and UTI Retirement Solutions. An eighth fund manager is yet to be incorporated by Birla Sun Life Insurance Co. Ltd. In the private sector, investors can choose from three funds—government securities funds, fixed income instruments other than government securities funds and equity funds in which the investor cannot invest more than 50%.

The report recommends a timeline of six years in which the industry will move to the new regime in a phased manner. In the first phase, the report recommends steps such as merging government and private sector NPS schemes and allowing more play to pension fund managers in equity by allowing investments in shares that have derivatives in any stock exchange and permitting investments in equity both through the primary and secondary markets. The first phase also allows for lifecycle funds with the equity cap at 75%.

Depending on your age, the lifecycle fund automatically invests your money in different asset classes. It starts with a maximum exposure of 50% in the younger days and tapers as one reaches retirement. The report also recommends a switch to active management in the first phase and a limited exposure of 5% in new asset classes such as real estate through real estate investment trusts and alternative investment funds registered with Sebi.

The second phase increases the equity exposure to 75% and the third recommends no ceiling on asset classes but only a negative list of assets and instruments based on the experience of the last five years and some prudential ceilings like concentration ceilings.

The report has recommended bringing all the pension products under the purview of the PFRDA, noting that Sebi and the Insurance Regulatory and Development Authority of India continue to grant approval to such products.

“It would be in order to develop a contiguous pension system involving collection, investment, fund management, record-keeping and pay-outs for orderly growth of the pension sector under the single regulatory umbrella of PFRDA,” it said.

The report also said the fund management fee of 0.01% of the corpus—the industry arrived at this fee through an auction—was too low and recommended a fixed plus variable fee structure.

“The current charges are unsustainable and the recommendation to fix that will make pension fund business economically viable,” said Sumit Shukla, chief executive officer, HDFC Pension Management.